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When the stock market is rising and we see our investment positions in the black (i.e., in profit), it is not only easier, but we also become more willing to invest more money in the market. The opposite can also be true – it can become more difficult to invest when our portfolio is in the red (i.e., loss).
When stock markets are going down, like they have been recently, many of us may become fearful that any amount that we invest will be lost. In fact, seeing the value of our portfolio shrink may also make us want to sell our stocks.
However, one of the things that we should avoid doing when the stock market is falling is to stop investing. Even worse, liquidating our investments means we will not be able to ride any future economic upswings.
To prevent us from making panicked decisions in a stock market crash, we need to understand our risk tolerance.
Investors Need To Build An Investment Portfolio Based On Their Risk Tolerance
Just looking at recent stock market crashes — in 2020 and in 2008 — we can see that the market can go down swiftly and by a great deal.
Source: Screengrab from Tiger Brokers mobile trading app
In the screengrab above, we can see that the S&P 500 Index – a representation of the broad stock market – fell over 56% in a 5-month period from October 2007 to February 2008 (denoted by the left-most red circle).
In 2020, the S&P 500 Index fell nearly 32% in a month between mid-February and mid-March (denoted by the middle red circle). Most recently, we have seen the S&P 500 Index lose more than 20% since December 2021 (denoted by the right-most red circle).
If we cannot stomach this type of decline or have a short-term investment horizon, we could consider limiting our portfolio allocation to individual stocks or stock indexes.
This allows us to diversify into less volatile instruments like cash management accounts and bonds, including Singapore Savings Bonds (SSB), which are virtually risk-free, as well as build up our CPF savings.
What Should Investors Do When Stock Markets Are Going Down
Once our investment portfolio is in line with our risk tolerance, we will be in the right frame of mind to continue growing our portfolio, especially during a market crash.
Zooming in again to the screengrab above, we can actually see that despite the stock market crashes, the S&P 500 Index has always recovered and gone on to reach even higher levels.
Source: Screengrab from Tiger Brokers mobile trading app
In fact, the S&P 500 Index has delivered a total return of 12.6% per annum over the past 10 years (as of 30 December 2022). Looking even further back, a McKinsey report calculated that the stock market has delivered an average return of 6.5% to 7% per year (after inflation) since about 1800.
By looking at the long-term rather than being influenced by a short-term crash, investors will be able to make better investment decisions. If we believe in our investment thesis and allocation, market crashes represent opportunities for us to add to our positions at lower valuations.
If we are not confident of timing the market lows – i.e. the stock market can always go lower – we can choose to dollar-cost average (DCA) into the stock market. This enables us to invest more when prices are cheaper and less when prices are more expensive.
Dollar-Cost Averaging (DCA) Helps Us Buy More Assets When Stock Markets Are Down
Using a DCA investment strategy, we force ourselves to be consistent in our investment approach, regardless of whether the market goes up or down. This takes our emotions out of the picture.
What’s even better is that we naturally buy more assets with the same amount of investment when prices are down and less when prices are up.
For example, if we wanted to invest $12,000, we would have been better off using a DCA strategy in 2022 compared to investing it all in January 2022.
If we had invested in the S&P 500 in January 2022, we would have bought 2.66 units at a unit price of 4515.55. By December 2022, the value of our investment would have dropped to $10,213.07 – delivering a 15% loss.
Investing $1,000 each month, we would have bought slightly more units – 2.96 units. By the end of 2022, our portfolio would be worth $11,352.13. Even though we still would have lost $648, we would have been better off compared to investing a lump sum.
|Month||Investment Amount||S&P 500 Index Price||Units Bought||Portfolio Value|
In the table above, we can also see that in the month when the S&P 500 Index fell near its lowest point in September 2022, we would have bought the most units (0.28 units). When it was most expensive, in January and March 2022, we would have bought the fewest number of units (0.22 units) in the year.
Using The DCA Strategy Over The Long Term
Apart from buying more units when prices are lower, investing on a regular basis eliminates the need for stock picking and market timing expertise, as well as the time required to monitor our portfolio. Moreover, we can also start investing with a small amount (i.e., as low as $100 each month). This way, anyone can start investing as early as possible.
In a bear market, we would also not know when it would bottom out, how long it would last, or how swift the recovery might be. As such, we cannot simply choose to stay out of the markets for extended periods of time. In the S&P 500 Index chart above, we also saw how the stock market eventually recovered – and even surpassed previous highs after each crash.
At the end of the day, stock prices in the market can be volatile and fluctuate from month to month. A DCA strategy keeps us disciplined enough to invest in the market on a regular basis. Furthermore, by investing regardless of where prices are, we will end up investing at an average cost over the long term.
What Would You Do In 2023?
Aside from looking forward to more travelling, another trying year might be in store in 2023. Against the backdrop of higher interest rates, persistently high inflation, and a slowing global economy, the financial markets may continue to remain volatile.
While adopting a dollar-cost average strategy may make sense in the current market environment, having a professional take on the key investment trends for 2023 can also be beneficial. Fortunately, investors can attend Tiger Brokers’ annual flagship What Would Tiger Do 2023 immersive experience on 14 and 15 January 2023, from 10am to 8pm (last entry 7.30pm), to glean more insights on the global market outlook.
Both new and even experienced investors can benefit from industry insiders sharing their thoughts on global economies, such as Singapore, Japan, USA, China and Europe. As these are typically locations that Singaporeans also love to travel to, it pays to be aware of the state of these economies (as we contribute tourism dollars).
Held at the Visual Arts Centre (the Glass-house Exhibition Gallery above Dhoby Ghaut MRT station), attendees at the What Would Tiger Do 2023 event will get first-hand insights from finance professionals in Singapore.
Attendees will also get to enjoy an immersive “Tiger experience” with storefronts by leading F&B brands, free ice cream and KOI bubble tea, goodies and more! You can also Spin The Wheel at the What Would Tiger Do (WWTD) store to win attractive prizes. Earn more chances to Spin The Wheel if you have:
– Have a Tiger Trade Account
– Have a Funded Tiger Account
– Post a post/story on Instagram/Facebook with #WWTD2023 and tag @tigerbrokerssg
Participants can also take part in the Market Outlook quiz at the WWTD store for a chance to win a suitcase from Rimowa (worth up to $2,000) and travel-themed swag bags (worth up to $250)
Get your free Priority Queue Tickets now!